For many years a reverse mortgage was seen as a last resort for older people who had a lot of home equity but were cash poor. Today, it’s about to become a mainstream financial strategy. Or at least that’s what financial service firms and federal regulators are hoping for. But you should be cautious about jumping in and understand that it could be a very good friend or a very bad one.
The basics of a reverse mortgage
A reverse mortgage is one that lets you borrow against your home equity once you are 62 years old or older. The money can be taken as monthly payments for as long as you occupy the house, as a lump sum, as advances through a line of credit or some combination of these.
The good news is that a reverse mortgage doesn’t have to be repaid until you move or die. To be eligible for a reverse mortgage you must own your home free and clear or you must pay off all existing liens with proceeds from the reverse mortgage. In the event you have an existing mortgage balance, you will pay it off completely with the proceeds from the reverse mortgage at time of closing. Generally speaking, there are no credit score requirements to get a reverse mortgage.
How much could your borrow?
The amount that you can borrow on a reverse mortgage generally depends on four things – the current interest rate, your age (the older the better), government imposed lending limits and the appraised value of your home.
How a reverse mortgage could be your best friend
There are several important pros to a reverse mortgage. For one thing, it’s easy to qualify for one, as there are no income requirements or any credit score requirements. Second, a reverse mortgage allows you to stay in your home. A reverse mortgage would allow you to pay off any existing mortgage so that you would never again have to make mortgage payments. Just as important, a reverse mortgage can never get “upside down.” This means your heirs would never be personally responsible for anything more than what the home sells for. Your heirs that inherit the house would be able to keep any remaining equity after they pay off the balance of the reverse mortgage. The proceeds from a reverse mortgage are not taxable and the interest rate could very well be lower than traditional mortgages and home equity loans.
These mortgages have had many problems. In particular there has been some very misleading marketing and inappropriate lending – at least according to the Consumer Financial Protection Bureau. In response to this, there are now federal rules that went into effect recently. One of these reduces how much of your home’s value you can borrow against. This new legislation also requires lenders to make sure that you can cover the upkeep of your home, as this is where many older couples ran into problems. They used the money for a better lifestyle, forgetting that their homes required upkeep. When a major problem occurred such as needing to replace the roof, there just wasn’t enough money to cover the cost and they were forced to take out new loans.
For one thing, a reverse mortgage has the same fees as a traditional FHA mortgage (see more details below) but are higher than conventional ones because of the insurance costs. These costs includde FHA mortgage insurance and an origination fee. Between the higher interest charges and the upfront fees you might be surprised at how little money you actually get. While it’s your equity, the bank will get a lot of it.
Second, your heirs might not get the house. With a reverse mortgage the loan is paid off when the house is sold. This means your heirs won’t get the house. However, it is possible for them to keep it if they pay off the reverse mortgage after your death. However, as a rule this means that the money will come out of your estate, which will reduce the total amount that your children and grandchildren will get. If you hope to leave a legacy, this can be a real negative.
A third con is that if you move out you will have to repay the loan. The fact is that the only way you can keep from having to repay the loan is by staying in the house. You will be considered to have “Moved out” if you haven’t lived in your house for a year. This includes if you moved into a long-term care facility. This means if you are no longer able to stay in your home, you must start repaying that reverse mortgage – at a time when money is likely tight for you. This can put a strain on any budget.
It’s important to keep in mind that you will still be responsible for maintaining your home and paying its costs. You will need to pay property taxes, your homeowners insurance and for regular maintenance on the house. Even if you can get a reverse mortgage big enough to cover all these expenses, this can still make for a difficult situation.
Finally, the balance of the reverse mortgage loan gets larger over time while the value of the estate or inheritance might decrease. While your Social Security and Medicare will not be affected, Medicaid and other need-based government assistance programs can be affected if you withdraw too much funds and do not spend them in one month. Finally, reverse mortgages are not well understood by most people. Fortunately, there is independent reverse mortgage counseling available that can help.
Making these loans more appealing
The financial service companies have tried to make these loans more appealing. One Columbia Business School professor said that “home equity is the key to Americans’ retirement security, so it’s crucial to responsibly offer reverse mortgages.”
Some financial advisors are even promoting reverse mortgages as a sort of standby credit. These are not like home-equity lines of credit that can be frozen during a financial crisis. In comparison, reverse mortgages will always stay open. If you leave the mortgage untapped, your credit line will actually grow each year by the interest rate you are charged. This makes it a great way to build a hedge against future financial needs.
Approach it carefully
You do need to approach a reverse mortgage carefully given the stakes involved. Here’s how:
Weigh the costs
If you were to get a reverse mortgage on a $500,000 home, you could pay $2500 for mortgage insurance, $3000 in closing costs and a $6000 origination fee. Given these steep upfront costs, this makes it even more important to take a hard look at other resources. For example, do you have a cash-value life insurance policy you could tap? Or could you trim your spending?
You would have to pay these closing fees even for a line of credit that you don’t use. In this case, there would at least be a peace of mind knowing that you have a sure source of cash and don’t have to sell if times get tough.
Make sure you will be staying put
If you think that you will be in your home for many years, than a reverse mortgage could make sense. Just remember as you age, you might want to make a move. For example, you might decide you want to be closer to your kids or grandkids. While a reverse mortgage may no longer be something of a last reboot sort, it’s still a tough call.